First a bit of history (just a bit, I promise). In the 80’s California law began requiring that insurance companies offer earthquake insurance. Then, in 1994 the Northridge Quake hit and was a wake up call to the insurance industry. Suddenly the entire industry discovered they had underestimated the damage caused when a major quake hits a heavily populated area. Almost overnight, the homeowners insurance market dried up in California. Companies sought to limit their exposure so they would not be facing ruin when “The Big One” hits. The only way to not have to offer earthquake insurance was to not sell homeowners either. Thus, the California Earthquake Authority was created.
What is the California Earthquake Authority
The CEA is a privately funded, publicly managed agency designed to remove the risk of earthquake exposure from the insurance companies. Most of the insurance companies doing business in the State of California participate. The CEA is the largest writer of earthquake insurance in the state, writing over 70% of earthquake insurance policies statewide. The CEA offers a very basic policy which satisfies the minimum coverage requirement of California law which is essentially coverage on the dwelling and little else.
Why the Huge Deductible for Earthquake Insurance?
Because of the high probability of a major earthquake in the coming years, to make earthquake insurance affordable it is specifically designed to be a disaster type coverage. Therefore, deductibles for earthquake insurance are much larger. Smaller claims will typically fall below the deductible, thus keeping premiums much lower than they would otherwise be.
The most common deductible for earthquake insurance is 15%, although lower deductibles of 10% or even 5% can be had. It is important to know that the deductible for earthquake insurance applies to the amount of coverage, not the amount of loss. So, if a home is insured for $250,000 and has a 15% deductible, the home must sustain damage over $37,500 before the insurance begins to pay.
How Do I Choose a Coverage Amount for My Home?
With all CEA policies, the coverage amount is determined by what limit of coverage you carry on your homeowners policy. Herein lies the potential for a huge problem. That figure is just an estimate of what it would cost to replace your home in a normal construction market. As people in disaster areas most often discover though, a post-disaster construction market is not normal.
Just Because You Have Earthquake Insurance, It Doesn’t Mean You Are Adequately Covered
Most homeowners insurance policies provide some form of “Extended Replacement Cost”. This provides an additional amount of Dwelling coverage on the policy in the event of total loss. Extended Replacement cost is so the homeowner does not have to foot the bill should it turn out that the actual cost to replace the home exceeds the amount of coverage on the policy. This happens surprisingly often. Marshall & Swift/Boeckh, the industry leader in replacement cost calculation software, estimates that 61% of homes are actually underinsured and on average the gap is 18%. And that’s true in the best of times. Following a widespread disastrous earthquake, material and labor costs will increase greatly.
Problem is, the overwhelming majority of earthquake insurance policies offer no sort of Extended Replacement Cost coverage. Such a scenario, where rebuilding costs rise dramatically following a major earthquake, could leave many homeowners who thought they were covered without the necessary funds to rebuild.
All is not lost, however. Let’s remember that the limit of coverage is the most they will pay, after the large earthquake insurance deductible. So if the construction market does not increase costs more than the deductible you carry, you might be OK. That’s a big “if” though. However, there are other coverage options which I will get into in a bit.
Earthquake Insurance Policies Are Much Different than Homeowners Insurance
As you may have noticed, earthquake insurance offers are generally for much less overall coverage than comes with a typical homeowners policy. While coverage for the dwelling is the same as on your homeowners policy, that’s where the similarity ends.
Minimal earthquake insurance under California law has several shortcomings. Among those are:
- Only $5,000 coverage for Personal Property (TVs, furniture, clothes, etc.),
- A mere $1,500 for Additional Living Expense (also known as Loss of Use),
- No coverage for other structures (detached garages, sheds, fences, etc.)
- Very limited Building Ordinance Coverage (see below).
The CEA does offer the option to increase some stripped down coverages, at additional cost, but no coverage is made available for other structures.
Building Ordinance Cost Coverage
Building Ordinance Cost (BOC) coverage is the most important coverage you have no idea about. Unfortunately, most agents do a very poor job of explaining the coverage or don’t explain it at all. In fact, in my experience I have discovered that very few insurance agents even have a proper understanding of the coverage.
To put it briefly, homeowners policies are designed to pay to repair or replace your home exactly as it stands today, not pay for additional costs solely caused by enforcement of building codes. The most glaring example is if a home is more than 50% destroyed, most municipalities will require that the remainder of the home be demolished and the entire home be rebuilt. A typical homeowners policy will pay just for the damage and not for all of the extra costs resulting from enforcement of that building code. If you have ever seen a partially destroyed home sit unrepaired for years, there is more than a fair chance that this is the reason why.
Most home insurance policies and most earthquake insurance policies will only include about $10,000 in BOC. Obviously, in the above example, that would definitely be inadequate. Many home policies will let you increase that coverage but most earthquake policies will not.
Overcoming CEA Earthquake Insurance Shortcomings
While the CEA dominates the earthquake insurance market it’s not the only player. As often happens, the private marketplace has responded to the scarcity of earthquake insurance options and came out with products that not only provide better coverage but usually cost less as well. Also, since the private companies tend to avoid all of the highest risk areas with less stable soil, one could argue that they will be in a much better claim paying position following “The Big One”.
The “Looks Like a Homeowners Policy” Policy
Many companies now are offering earthquake policies that have limits of coverage similar to a traditional homeowners policy. They have a dwelling limit based on replacement cost then have other coverage limits based off that dwelling coverage limit. For example, such a policy might include an additional 10% of coverage for Other Structures, 50% for Personal Property and additional coverage for Loss of Use. Quite often these policies will also provide coverage for things excluded from the basic policies like coverage (although limited) for things like masonry veneer and swimming pools. Typically, these policies will have separate deductibles for each of the coverages. A simple example of one of these types of earthquake policies:
Coverages (Deductible 15%):
Dwelling: $250,000 ($37,500)Other Structures: $25,000 ($3,750)Personal Property: $125,000 ($18,750)Loss of Use: $25,000 ($2,500)
Combined Limit (‘Blanket Limit’) Policies
This is probably my favorite type of earthquake insurance policy for two reasons: It is usually slightly more affordable than the separate limit policies like in the previous example and it offers greater protection against inadequate coverage on the dwelling. Therefore it would be better suited to protect against increased construction costs in the event of a total loss to the dwelling. The way it works is this: Rather than split up the limits for all the different coverages, it instead combines them into one ‘blanket’ limit under which all losses would be paid. So to compare to the prior example:
Coverage (Deductible 15%):
Blanket Limit: $425,000 ($63,750)
The upside is that if the actual cost to rebuild the home were to exceed the estimated amount of $250,000 (plus the deductible), the additional costs could still be absorbed under the blanket limit. The downside to such a policy is that no claims are paid until the deductible is met. The net effect is that for moderate claims where the home is not totaled, it is likely that the policy with separate limits would result in more being paid out to the insured due to lower per-coverage deductibles. However, in the event of a severe or total loss, the blanket limit policy provides more coverage to rebuild the home. However, that extra coverage may come at the expense of less coverage on the other types of losses such as personal property.
The Best of All Earthquake Insurance Coverage
A few companies offer endorsements that extend their homeowners policy to also cover earthquake. While these endorsements will include larger deductibles just like other earthquake insurance policies, they also can potentially provide much more coverage through Extended Replacement Cost coverage and substantially more Building Ordinance Coverage. However, because these policies offer much better coverage, they tend to be the most expensive of all earthquake policies. Additionally, these policies are harder to find but if you really want the best earthquake insurance out there, this is the way to go.
So Which Earthquake Insurance Is Right for You?
As with all insurance, it depends on your needs and your budget. The important thing is to give yourself options. Ask your agent or insurance company what options they have for earthquake insurance. If all they have is one option, their company’s option, obviously that is what they will recommend. If they can’t offer you multiple options, find an agent that can. It may seem confusing but a good agent should be able to lay out multiple options, discuss the strengths and weaknesses of each and let you decide. After all, you are going to be the one who lives with the consequences when the “Big One” strikes.